Unknown unknowns are delaying investments and slowing down the energy transition

A deep uncertainty made up of “unknown unknowns” is delaying investments in energy transition technologies such as offshore wind farms or electric vehicles which in turn is slowing down the speed of the energy transition, according to new research from a team of Frankfurt School of Finance & Management.

The researchers examine cases of uncertainty where neither policymakers nor market actors have estimates or probabilities to work with in tackling these issues. Their analysis identifies that under these circumstances, decision-makers find it difficult to make any investments, as traditional tool kits how to assess and handle risks do not work when it comes to such deep uncertainties. To tackle this issue and reduce deep uncertainty, the researchers say policymakers must make credible commitments, signalling that, for example, the path towards zero emissions by the year 2050 will eventually be implemented. This would allow better forward-looking planning and investment.

The research was conducted by Ulf Moslener, a Professor of Sustainable Energy Finance at Frankfurt School, alongside with his colleagues Christian Haas and Karol Kempa from Frankfurt School - UNEP Collaborating Centre for Climate & Sustainable Energy Finance, who were keen to understand exactly what sources or drivers were holding back energy transition, both on the policymaker and investor sides.

The researchers reviewed three cases of energy transition in two key areas: power generation and the transport sector. The first case was the construction of a new coal-fired power plant; the second the rapid expansion of electricity generation based on renewables, the offshore wind industry; and the third the phase of the introduction of electric vehicles in the German automotive sector. Using these three examples, they were able to show what is hindering the energy transition in these sectors and what would be needed to ensure that the energy transition was quicker and more efficient.

The researchers found that deep uncertainty can be generated through the combination of simpler cases of uncertainty. For example, if technological development and dynamics in the economy and the broader society interact, path-dependencies, multiple equilibria, and complex systems may arise, making predictions significantly more difficult.

Professor Ulf Moslener says,

“Energy infrastructure is capital intense. We know that we need substantial investment in clean energy, and we know that we need it fast. Investors and policymakers can best work together on this if the policy signal is such that investors can rely on it. And to be clear: that is not easy. A simple law that can easily be changed, will not do the job. Financial contracts, such as contracts for difference simulating a high carbon price for investors, may be more helpful.”

The researchers state that these results have vital, practical implications on how policymakers and investors can work together more effectively if we are to reach energy transition at a faster and more efficient pace.

The government needs to send a credible long-term signal that the transformational change will happen. There may be concerns about this inducing costs and risks to the competitiveness, but that could at least partly be compensated by strong and broad government support of research and innovation, say the researchers.